As most investors may know by now, Intel Corporation (INTC) lowered its third quarter revenue forecast due to weak PC demand. Most analysts believe that the second half of this year is going to be one of the weakest years for computers in about 20 years. That will obviously impact this chip giant. Now when Intel lowered its quarterly forecast, it did not lower its full year forecast. That means that Intel should be cutting its full year forecast when it reports earnings next month. This shouldn't come as a total shock, as analyst have been cutting forecasts by the week. But the question remains, how much will they lower the full year forecast, and how much of it is priced in already? Intel shares are already at levels not seen since late 2011. Let's analyze the fundamentals and try to determine Intel's financial future.
The base case
When Intel reported its second quarter results in July, the company stated that 2012 first half revenues were $26.407 billion. That number was up about 2% from the prior year period. Now at that same report, Intel lowered its 2012 revenue growth forecast, which pretty much everyone expected. Intel's prior forecast was for 7% to 9% revenue growth this year, but the new forecast called for growth of just 3% to 5%. Remember that 4% midpoint. It will be important going forward.
Since Intel guided to a midpoint of 4% revenue growth, and in 2011, the company's revenues were $53.999 billion, that means that it was guiding to a midpoint of $56.159 billion for the full year (2012). Since it guided to a midpoint of $14.3 billion for the third quarter, that meant that the fourth quarter would need $15.45 billion of revenues to achieve that 4 percent yearly growth number.
Applying the warning
When Intel warned on the third quarter, it gave a new revenue midpoint of $13.2 billion, or $1.1 billion below what they originally had guided to. So for it to now achieve that 4% yearly growth, it would need to do over $16.55 billion in fourth quarter revenues to hit that mark. Given that last year's period saw $13.89 billion, that means that Intel would have to have nearly 20% revenue growth to hit that mark. I think most realize that figure would be pretty impossible.
Now even if Intel still expected that $15.45 billion for Q4 that it essentially guided to, and you assume the $13.2 billion for this quarter, that gives 2012 yearly growth of 2%. Since its latest forecast was for 3% to 5% growth, that means the forecast will have to be cut. I'm not sure anyone still expects around $15.45 billion, so two questions remain. How much is the fourth quarter cut, and how much is the full year cut?
Since Intel cut its Q3 forecast by 7.7%, let's assume that the Q4 number is cut by that much (from the $15.45 billion). If that were to happen, the Q4 number would be approximately $14.26 billion. Add that to the first half total and the $13.2 billion for Q3, and you would have a total of $53.87 billion, representing a 0.24% decrease for the year.
The analyst take
For the third quarter, Intel analysts currently project an average of $13.2 billion in revenues, the exact midpoint of Intel's guidance at the warning. However, for Q4, analysts are even more bearish than my last point from the section above. Currently, analysts expect revenues for Q4 to be $13.81 billion. While that is only a 0.5% decline from last year's period, it's a number about 10.6% lower than the effective $15.45 billion guidance Intel gave at the Q2 report.
Currently, that means that analysts see Intel revenues for the year declining by a full percent. Given Intel's recent guidance for 3% to 5% growth, that means that analysts have taken down their midpoint by five full percentage points. For them, most of the expected takedown is priced in at this point.
The analyst community still continues to be negative over the PC industry slowdown, and they don't think that Microsoft's (MSFT) Windows 8 launch will be a huge savior. An analyst at Evercore Partners took down his PC unit forecast for 2012 and 2013. His old forecast was for no growth this year, but 4 percent growth next year. The new forecast calls for a 4 percent decline this year and no growth next year. The following quote sums up his report.
"Tablet cannibalization, weak macro, disappointing Ultrabooks, and inventory burn into Win8 now make 2012 look on pace for the PC's biggest decline in 20 years, with limited reasons to expect next year recovers beyond just flat," he writes in a research note. "PC weakness is likely news to no investor at this stage, but looks brutal nonetheless, as we estimate Q3 units fall year-over-year across every major market: Consumer, corporate, desktop, notebook, U.S., Europe, and APAC."
The firm cut its forecasts on both Intel and chip name Advanced Micro Devices (AMD), as well as computer names Dell (DELL) and Hewlett-Packard (HPQ). The Intel analyst for the firm cut his 2013 revenue forecast from $55.1 billion to $54.5 billion, and his earnings estimates for next year from $2.20 to $2.15. The current analyst average is for $55.74 billion and $2.21, respectively.
On a separate note, research firm Caris recently cut its price target on Intel from $29 to $26. The firm noted, yes, you guessed it, weak PC growth. These are just two reports of bearish analyst notes so far this week, you can find dozens more in recent months.
Microsoft's Windows 8: The savior?
Earlier this year, it seemed to me that everyone was expecting a huge and successful launch of Microsoft's new operating system. But after watching the success of Apple's (AAPL) new iPad, along with the expectations that Apple may release a mini-iPad in October, expectations for personal computers are going down. You've seen how bad things are in the PC arena, with Dell and Hewlett Packard both issuing warnings at their latest earnings reports. If the Windows 8 launch was initially expected to be great, I'm guessing the feeling now is for the launch to be good, or just okay.
If the Windows 8 launch turns out to be poor, the implications for Microsoft are great, but it would also confirm all the PC industry troubles we've been hearing about. That does have negative consequences for Intel, so we'll see how that goes over the next couple of months.
Dividend rising, Buybacks declining?
With the latest fall in Intel shares, the stock is now yielding 3.97% on an annual basis. We're just a stone's throw from a 4% yield. Intel and Microsoft are the two top value plays in the technology space, known for their impressive dividends and stock buybacks.
But as I noted in my latest Intel article, the falling net income figure Intel will see in the second half of this year will have an impact on its cash flow. Intel could see net income decline by over $1 billion in the second half of this year, compared to last year's figures. That means cash flow from operations will decline a little, and what do you think pays for the buyback?
Don't forget, Intel announced an equity investment in and R&D partnership with ASML. Intel will invest about a billion dollars in R&D and about $3 billion in the equity investment. The company states it will use foreign cash for the purchase/spending, and says it will have no impact on the buyback or dividend. However, Intel doesn't have the $40 billion or higher cash pile some other tech giants do.
Given the reduction in cash flow from operations (mostly net income), as well as the fact that Intel paid out $150 million more in dividends in the first six months of this year than last, I think that the buyback will see some pressure. While I still expect it to buy back a fair amount of shares, it just won't be as much as they it in prior years.
This already has started, with the company stating on page 37 in their recent 10-Q:
"The decrease in cash used for financing activities in the first half of 2012, compared to the first half of 2011, was due to lower repurchases of common stock under our authorized common stock repurchase program."
Final Thoughts and Recommendations
I just don't see any possible scenarios where Intel does not reduce its full year forecast when it reports earnings. The second half of this year appears to be one of the worst years for PC sales in decades, and Intel is certainly feeling the pinch.
When Intel does reduce the forecast, I expect the new revenue growth forecast to be in the range of minus 3 percent to a positive one percent. Obviously, Intel would have to have a dynamite fourth quarter to hit the high end of that range. But a truly bad quarter could send things to the low end of the range. Currently, analysts are in the middle of that range, forecasting a one percent drop in revenues this year.
That being said, if Intel misses its third quarter numbers, this stock could easily decline some more. Remember, Intel's original forecast for the quarter was below expectations, and then it warned on top of that. The fourth quarter guidance is not going to be pretty, but since analysts have really lowered expectations, the bar is fairly low at this point.
It seems like we are seeing analysts cut their forecasts almost weekly, so I think that the average analyst estimate could still continue to come down. We still have a few weeks until earnings. I'm not sure Intel will miss the expectations bar (because it is so low), but if it does, that means things are much worse than we originally thought, and in that situation, I think shares could head towards $20.